Software, Hardware, and Exchange wallets balance security with ease-of-use.
When money was physical, storing it safely relied on physical means. Stuffed mattress, safes, bank vaults… Storage has always been an important part of conserving wealth. As our wealth finds its way to the digital frontier, so too does our search for safety and security.
With cryptocurrencies, the financial world jumps firmly in the digital world and the security of this new asset class does not rely on physical means only; your wealth in cryptocurrencies is secured by a cryptographic secret called a private key that is necessary to perform operations on the blockchain.
My colleague Davey explained this in depth here. To explain briefly, you can imagine that an address on the blockchain is like a mailbox. Everybody knows the public address and can send items to it, but only you with your private key can you open the box.
Private keys are a string of numbers and letters that are unique for each asset of a wallet. They are used to generate the public keys and these public keys are used to generate the public addresses you use to receive cryptocurrencies.
Because it is so important in the long-term, it's safe to say that securing your private key is currently one of the biggest challenges in the space right now.
Cryptocurrency most important areas for improvement over the next few years:Nick Szabo⚡️ April 24, 2018
* More secure storage (key management)
* Trust-minimized (decentralized) exchanges
* Make 2nd layers more user-friendly, especially via automated routing, while not overly sacrificing trust minimization
As highlighted by S̶a̶t̶o̶s̶h̶i̶ , well… Nick, the current balance between security and user-friendliness is not optimal. Right now, the more secure you want to be, the less liquid your assets become. This means that depending on your priorities, you will want to use a different tool.
In the current ecosystem, three unique solutions have emerged to take care of your cryptoassets: exchange marketplaces, software wallets, and hardware wallets.
Each takes a different approach to securing your digital assets. They all come with pros and cons; it’s important to understand these so that you can make the best decision for yourself.
Exchange marketplaces, generally abbreviated to exchanges, have a simple approach: They hold private keys, you don’t. This way, you can’t misplace them, lose them, or have them stolen.
This means you are trusting a third party to keep your funds secure. Many early users sought out cryptocurrency specifically because it gave the individual total control over their wealth, so to many this may seem like a step backwards.
But there are also upsides to storing funds on exchanges. There are no network fees and trades happen quickly because they are done off-chain in the exchange’s database and not sent over the blockchain. This makes exchanges the best place to trade quickly and today most of the volume in the cryptospace happens there.
Some exchange services even have insurance policies that cover lost funds (under certain conditions), so like traditional banks, if you are okay with waiving ownership and letting someone else protect your funds, you can consider leaving your cryptoassets on exchanges.
A word of caution: Because exchanges pool the funds of many people, they naturally become a target for hackers and security breaches can occur. This causes not only financial loss for you as a user, it can also have negative long-term effects on the ecosystem. Many blame the fall of MtGox for the bear market that followed. Worst, when the MtGox exchange closed doors in 2013, the assets put under the name of all the people using the services were frozen and to this day, they haven’t been able to access their money.
Summary: If you’re interested in trading and don’t mind leaving your private keys in the hands of a third party, then you may consider using an exchange. Otherwise, you’re likely better served with alternative options: software or hardware wallets.
Software wallets are the next step in personal security. With a software wallet, you own and control your private keys without relying on supplementary hardware. This balance between security and control is a sweet spot for many users. It’s why Exodus was first conceived as a software wallet.
The software wallet lives on your computer and the operating system, and personal security measures become very important here.
Software wallets balance security with convenience. They operate on a computer that needs to be connected to the internet and constantly exchanges information over the network. Most of this information carries little to no risk, but being online opens the door to unwanted transfers of information due to malware, viruses, or keyloggers. This is why we keep repeating:
This is true for all software wallets, not just Exodus. If a malicious person manages to break into your computer they can take advantage of this in many ways, from accessing passwords to confirming financial transactions.
At Exodus, we highlight what the “wallet” analogy means. Seeing software wallets as you would a regular wallet means:
- You’re not going to put your life savings in it.
- You know you can lose what’s in it if you aren’t paying attention.
- You count on yourself to secure your wallet.
Assuming that you are clear on the security of your software wallet, you can enjoy its many benefits, primarily a seamless experience with full control of your wealth. The Exodus wallet and some other wallets even have additional features such as a built-in exchange where you can securely and pseudonymously exchange cryptocurrencies.
An additional benefit that attracts customers is that, contrary to exchanges, these wallets do not require giving up any privacy.
It needs to be stressed again: Software wallets give you control over your wealth. You don’t have to reveal your identity to the wallet provider before using it, you do not waive ownership of your wealth for convenience, and you rely on the trustlessness built in the blockchain networks to perform operations. Contrary to exchanges, you really own the cryptocurrencies that are sitting in the wallet.
With this control comes responsibility. All the private information is held on your computer and you must be very attentive to your actions and the safety of your computer. If security and ownership is important to you but you’re unsure whether you can take all the necessary measures to protect your funds, then at a relatively small price, hardware wallets will take care of the security for you.
Summary: Software wallets are great for storing a comfortable amount of cryptocurrencies or for quick moves rather than long-term, high-value storage. They strike a balance between total security and effortless convenience.
Hardware wallets are arguably your most secure option for one simple reason: Your private keys never touch the Internet.
These private keys never leave the device so no one can access them and claim ownership of your assets. To do this, a hardware wallet sign the transaction offline and then broadcasts it. Hardware wallets do that by having a “secure element” that holds your private keys and a very limited ability to talk to the rest of the device (for example, it cannot send info bigger than the size of a signed transaction, which means that you cannot add data to it to tamper with the element). For a deep dive into the security of hardware wallets and how to break it, I warmly encourage you to read this article.
The problem here is that hardware wallets are not very convenient to use on the fly, and the experience can be difficult to navigate at times. Some may argue that the security is so high that it can lead to writing one of the most fascinating articles on lost bitcoin.
Hardware wallets aren’t free, and for many people, the added security isn’t worth the price of purchase. Our advice is that, at around $100, if you plan to invest a significant amount of your wealth in crypto, you should seriously consider owning a hardware wallet.
Paper wallets are another way to protect assets, but we won’t go into details here as what can be said about hardware wallets is relevant for paper wallets. They function in a way that is different from the other storage solutions and have separate concerns like ink fading and printer history. Maybe for another time.
Summary: Hardware wallets are an up-front investment and lack some convenience, but if you want the greatest level of security for your wealth, this is what you need.
The Storage Solution For Me
Let’s review what we’ve discussed here so that you can make an informed decision:
|Type of Wallet||Pros||Cons|
-Third party security management
|-Magnets for hackers
-No direct control over assets
-Must trust third parties
|Software Wallets||-You own your assets
-Fast, available all the time, everywhere
|-You are responsible for your security
-Ultimately dependent on how secure your local computer is
|Hardware Wallets||-Most secure
-Private keys generated and stored offline
-Less convenient/accessible experience
The best strategy is to use all three storage solutions together.
This allows you to trade quickly as the market moves on an exchange, test new cryptocurrencies on a software wallet, and move your new wealth to a hardware wallet for long-term storage.
The crypto-ecosystem has recognized this balance and is moving towards a more unified experience. You will see hardware wallet manufacturers create better software interfaces with the possibility of trading, software wallets integrating exchanges and better security (such as offline signing or 2FA) and the arrival of decentralized exchanges where all the transfers occur anonymously over the blockchain, removing many of the pain points centralized exchanges have.
Now that you’ve given it some thought, we’d love to hear what you think about it! Which type of security solution do you use? Do you use multiple options? What makes you prefer one over the other? What is your “crypto setup”? Let us know in the comments below!
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This post first appeared on Steemit as an exclusive article but was also reblogged on the Exodus Movement Medium page. We give the <3 to our fellow Steemians first and foremost, but this article may appear elsewhere after its initial publication.